What Is Deflation?

The question “what is deflation?” is easy to answer. Deflation is a decrease in the total volume of money and credit. Conversely, inflation is an increase in the total volume of money and credit.

Some sources add “relative to the supply of available goods” to the definition, but this phrasing is designed to account for rising or falling prices, which are among the effects of deflation. Theoretically speaking, supply restrictions for certain goods could be so severe during an episode of deflation that prices for those goods could rise; but this situation would not negate the fact that deflation had occurred.

Effects of deflation: Deflation typically leads to falling investment and commodity prices, producer prices and eventually consumer prices. These changes are due primarily to an increase in the value of the surviving units of money and credit, but deflation can also lead to economic contraction, which typically dampens overall demand for goods, thereby increasing the tendency for prices to fall.